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2016 First Quarter Report: A Roller Coaster Ride

Written on April 19, 2016

The first quarter was a roller coaster ride, with stocks experiencing a decline of 11% by mid-February and then climbing back to end the quarter where they started the year. In our view, the U.S. economy appears to be in a mature growth phase, with little near-term risk of recession. This reinforces our positive stance on the equity markets; however, we could have bouts of volatility and pullbacks. Business fundamentals are improving and the Federal Reserve has decided to feather the brakes instead of thumping on them. Historically, staying invested and diversified has been a winning formula.

The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks and bonds—was up 1.17% for the first three months of 2016, which is remarkable considering that the index was down more than 10% by the second week of February. The Russell Midcap Index was also up 2.24%. The comparable Russell 2000 Small-Cap Index was down 1.52%, while the technology-heavy Nasdaq Composite Index lost 2.75% for the quarter.

Meanwhile, international markets have been mixed. The broad-based EAFE index of companies in developed foreign economies lost 3.74% in dollar terms in the first quarter of the year, in part because Far Eastern stocks were down 6.06%. Investments in the attractively valued emerging markets have started to bear fruit as the MSCI Emerging Markets Index gained 5.37% for the quarter.

In addition, interest rates have continued their downward drift, leading to gains in bond portfolios. The Barclays U.S. Aggregate index returned 2.96% for the quarter.

The easy call at the beginning of the year would have been to bail out when the markets were declining and to sit out the widely predicted start of a painful, protracted bear market. Some analysts were talking openly about another “Financial Crisis” drop in stocks. Nevertheless, 10% market declines are simply a part of the market’s normal turbulence, and anyone who spooks as soon as they see a month of bearish consequences is likely to miss out on the subsequent rebound off the bottom. Since hitting their 2016 lows on February 11, both the S&P 500 index and the Nasdaq Composite have gained roughly 13% in value.

Arguably, the biggest stabilizer of U.S. and global stock markets was the rise in oil or, more precisely, the end of a long unnerving drop in the price of crude that caused anxiety to ripple through the investor community. Investors seemed to take comfort in the fact that the price of the world’s most important commodity had stabilized. It is worth noting that the day the stock market hit its low for the year—February 11—was also the day when oil futures hit their low of $26.21 a barrel.

Why then have stocks and oil prices been connected at the hip? Aren’t lower energy costs a plus to all consumers of energy whether a company, a country or a consumer filling up at the gas station? The most logical explanation is the implied connection oil prices have on inflation. Lower oil prices cause lower inflation. This translates into higher real interest rates which are negative to stocks.

In the U.S., employment growth has remained strong, and manufacturing is showing signs of life. Internationally, the Eurozone is also reporting a moderately expanding manufacturing economy. Even Chinese officials have recently reported the first rise in an important manufacturing statistic—the purchasing managers index—in eight months. Emerging markets are also in a better relative position as oil and valuations help their cause.

Does that mean the stock market will go up? We cannot predict the future; indeed, even the present is hard to understand. Our mission as investors is to hang on and allow the millions of workers who get up every morning and go to work to do what they do best: incrementally, hour by hour, day by day, week by week, grow the value of the companies we own with their efforts. Investors will spook and sometimes flee stocks, driving their prices down. However, for the long-term, the returns on your investments are inexorably driven by the underlying value that is created by the work force in the offices, cubicles and factory floors all over the world.

Stay the course and allow your portfolio to absorb the inevitable bumps, and your reward will inevitably be a more secure future.